Gold PriceComments Off on Doug Casey: Likely to be a Super-Bubble in These Crappy Little Mining Stocks

Doug Casey, founder and chairman of Casey Research, was interviewed on Palisade Radio’s weekly show. In it he said: “As we speak, in the end of 2014, I think we’re pretty close to the edge of the precipice.”

WITH a career spanning three decades in the investment markets, Brien Lundin serves as president and CEO of Jefferson Financial, a highly regarded publisher of market analyses and producer of investment-oriented events.

Under the Jefferson Financial umbrella, Lundin publishes and edits Gold Newsletter, a cornerstone of precious metals advisories since 1971. He also hosts the New Orleans Investment Conference, the oldest and most respected investment event of its kind.

As Lundin here tells The Gold Report, he now believes at least a small amount of the massive liquidity produced by loose monetary policy in Western economies will find its way into mining equities following the summer pullback – but don’t wait long…

The Gold Report: On July 30, you sent out a Gold Newsletter alert that forecast a pullback in the midsummer bull market. The next day the Dow dropped 317 points, while the Nasdaq fell about 93 points. Since then the Dow has climbed back above 17,000, the Nasdaq above 4,600. Should investors dismiss that drop or do you believe it was akin to a tremor preceding an earthquake?

Brien Lundin: That particular call made me look like a genius at the time, but right after that drop the stock market took off and reached new highs. The stock sell-off in late July was a sign that investors were nervous because we haven’t had a meaningful correction during this bull market. However, there are potential pitfalls ahead for the economy – we still have to navigate the US Federal Reserve’s ending of quantitative easing and its first interest rate hikes. There’s nothing directly ahead that indicates a major correction will occur, yet these things happen when you’re least expecting them.

TGR: You’ve been warning investors in Gold Newsletter about the erosion of the foundation of the US equity market. Please give our readers a few points to underpin your thesis.

Brien Lundin: When I put forth that thesis, Q1 ’14 gross domestic product (GDP) had missed consensus estimates by 3.3%. The consensus going into that report was for 1.2% growth but it turned out to be just 0.1% – only to be subsequently revised further down to -2.1%. The miss for the consensus estimate was remarkable.

I posited that these reports had possibly captured some underlying weakness in the economy. I expected a rebound in Q2 ’14 because a lot of economic activity was put off due to the unusually cold winter weather. But Q2 ’14 GDP was over 4%. I certainly wasn’t expecting anything like that, and neither was anyone else.

So, the idea of a major stock market decline stemming from a weakening US economy has become more remote, at least for the time being.

TGR: What are you seeing now?

Brien Lundin: The massive amount of money created in developed economies since the 2008 credit crisis really has not resulted in significant retail price inflation. If anything, there has been disinflation in major economies, such as in Europe where the European Central Bank is now turning to quantitative easing. The real result of quantitative easing in the US and loose money policy throughout the Western economies is a virtual flood of liquidity looking for places to land. It’s why we have US Treasuries being bid down to their lowest rates ever, while the US stock market is hitting record highs. Those two asset classes should be at opposite sides of the seesaw, but there’s so much money looking for a home that both are soaring simultaneously.

TGR: The Market Vectors Junior Gold Miners ETF (NYSEArca:GDXJ) has been trading lower since mid-July. In fact, the Dow Jones Industrial Average has outperformed that ETF over the last month or so. Is that a buying opportunity?

Brien Lundin: I think so. The timing is critical, though. While I don’t see a near-term, fundamental driver to push the market higher in the very near future, there are some factors that I think will push the junior resource stocks and the metals higher this fall. So your real buying opportunity is probably over the next couple of weeks.

All of the liquidity that I referred to earlier has to go somewhere. There’s a broad consensus that gold is going lower and a lot of money is shorting gold. At some point over the next month or so – at the first sign that gold is not going lower – we’re going to see some short positions get covered, and that ocean of money is going to start sloshing into gold and silver. At that point we should also see stronger seasonal demand for gold and that also will help power the gold equities market forward.

TGR: Every year your company, Jefferson Financial, puts on the New Orleans Investment Conference. This year the show celebrates its 40th anniversary from October 22-25. The headline event is a panel discussion with former Fed Chairman Alan Greenspan, legendary investor Porter Stansberry and Marc Faber, publisher of the Gloom, Boom & Doom newsletter. What can investors learn from this?

Brien Lundin: On the Greenspan panel we’re going to pointedly ask him about the Fed and the Treasury’s role in manipulating the gold price and how that occurs, if it occurs. He no longer has any reason to obscure the truth. There will also be a moderated Q&A with Greenspan where he’ll take questions from the audience. Those two panels with Greenspan are going to make headlines, if not history. He has a fascinating story. Greenspan was one of the most ardent and eloquent goldbugs in the 1960s. He was a close follower of Ayn Rand and some of his writings on gold still stand today as among the best ever produced on the role of gold in protecting citizens from currency depreciation.

The rest of our lineup includes Dr. Charles Krauthammer, Peter Schiff, Rick Rule and Doug Casey. People come back year after year because they get to meet these experts and talk with them. They get stock recommendations and strategies that they’ll never get anywhere else. It’s always a dynamic event.

SO FAR this year, writes Frank Holmes at US Global Investors, small-cap growth stocks have surprisingly been lackluster.

After 2013, when it gained a scorching 38.8%, the Russell 2000 has delivered a tepid 0.62% year-to-date (YTD).

Performance has been so poor, in fact, that the spread, or bifurcation, between the 12-month return residuals of small and large caps is at its widest since the dotcom bubble of the late 1990s and early 2000s. This bifurcation is one of the largest since 1975.

According to Morgan Stanley, we’re in the worst beta-adjusted period for small-cap stocks since the late 1990s. The 12-month return in August for small-caps was -9.7%, placing it in the bottom 6% of any 12-month period since the mid-1970s.

The bifurcation is more than apparent when you compare the year-to-date (YTD) total returns of the big boys (those in the S&P 500 Index and Dow Jones Industrial Average) to their little brothers (those in the Russell 2000 and S&P SmallCap 600 Index).

The Russell, though it led the other indices in March, has failed to reach a new record high, which the S&P 500 and Dow managed to achieve in the last couple of months.

Are we on the verge of another bubble? We don’t think so. History shows bubbles are associated with excessive leverage and lofty valuations. That is not the case this time.

In July, Federal Reserve Chairwoman Janet Yellen stated in her semiannual report to Congress that small caps appear to be “substantially stretched,” even after a drop in equity prices at the beginning of the year.

There may be some truth to Yellen’s remark, an ideological echo of former Fed Chairman Alan Greenspan’s now-famous “irrational exuberance,” his description of investors’ rosy attitude toward dotcom startups of the late 1990s and early 2000s.

Much of the valuation gap has evaporated. Looking at the price/earnings to growth ratio – 20x for the Russell 2000 and 18x for the S&P 500 – small caps have slightly higher yet reasonable multiples and may offer better long-term growth prospects.

The recent underperformance among small caps has been a headwind for a few of our funds, most notably our Holmes Macro Trends Fund (MEGAX),whose benchmark, the S&P 1500 Composite, tracks the performance of not just large- and mid-cap US companies, but small-cap as well. With a bias toward small-cap companies, the fund has underperformed compared to last year, when such stocks were doing well.

Because small caps tend to have higher beta than blue chips, you would expect them to outperform in a generally rising market – which we’re currently in. So it appears that a major rotation out of these riskier, more volatile stocks has inexplicably occurred, leading to the wide bifurcation between small and large companies.

The good news is that, based on 20 years of historical data, stocks in the Russell 2000 tend to rally in the fourth quarter and continue steadily until around the end of the first quarter. Over this 20-year period ending in December 2013, the Russell has generated an impressive annualized return of approximately 10%.

Whether or not this fourth-through-first-quarter rally will recur in 2014 and early 2015 is impossible to forecast. What can be said, however, is that prices and returns do tend to revert back to their mean over time.

I discussed this concept in full last month in the second part of my Managing Expectations series,”The Importance of Oscillators, Standard Deviation and Mean Reversion“. Although small caps are underperforming right now, the concept of mean reversion suggests that they’ll return to their historical relationship with large caps eventually – just as they did following the dotcom bubble.

In his 2006 book The New Rules for Investing Now: Smart Portfolios for the Next Fifteen Years, investor James P. O’Shaughnessy makes the case that small stocks have a performance advantage over large stocks simply because, well, they’resmall. This might sound like circular logic, but as he writes:

“A company with $200 million in revenues is far more likely to be able to double those revenues than a company with $200 billion in revenues. With large companies, each increase in revenues becomes a smaller and smaller percentage of overall revenues. Small stocks, on the other hand, have a much easier time delivering great percentage growth in revenues and earnings.”

O’Shaughnessy examined every 20-year rolling time period beginning each month between June 1947 and December 2004. That’s 691 20-year rolling time periods. What he found is that “small stocks outperformed the S&P 500 84% of the time.”

If O’Shaughnessy’s research is accurate, it seems very reasonable to be optimistic in the long term. It would be myopic to look only at the Russell 2000’s recent underperformance and impulsively rotate out of small caps without also considering the decades’ worth of data showing the growth that can be achieved.

Comparing index funds to actively managed funds, Kiplinger columnist Steven Goldberg wrote last month: “[I]ndex funds are designed to give you all the upside of bull markets and every bit of the downside of bear markets. Only good actively managed funds can protect you from some of the pain of a bear market.”

We at US Global Investors agree with Goldberg’s attitude toward good active management. Although MEGAX might be temporarily underperforming right now as a result of the sentiment-driven and disappointing performance of small-cap stocks, we’re confident that they will eventually revert back to their historical pattern as fear over Fed tightening settles down and fundamentals prevail.

In the meantime, we will continue to apply our dynamic management strategy of picking stocks in the fund using the 10-20-20 model: we focus on companies that are growing revenues at 10% and generating a 20% growth rate and 20% return-on-equity. This approach has served us very well in the past and enabled us to select the most attractive growth-oriented companies for our clients.

On another note, and as I explained in a recent Frank Talk, a strong US Dollar could spell trouble for commodities such as gold, which tend to have a historic inverse relationship to the Dollar.

When the Dollar does well, investors often choose to store their money in paper rather than bars. Though September is statistically the best month for gold, with the Dollar rising almost two standard deviations above its mean, this month might not be kind to the yellow metal and other commodities.

Is the POST-COLD WAR global boom over? asks Donald Coxe, chairman of Coxe Advisors LLC, and a consultant to The Casey Report from Doug Casey’s research group.

Since the fall of Bolshevism, the world has seen remarkably sustained growth in international cooperation, brought about by freer trade and new technologies. Financial assets have generally performed well, increasing prosperity across most of the world. There were just two major interruptions – the tech crash in 2000, and the financial crash in 2008.

The world warmed up fast after the Cold War. Prices of most commodities rose, despite major corrections:

Oil climbed from $15 per barrel to as high as $140. It collapsed with the crash, but climbed back swiftly to near $100;

Corn climbed from $2 to as high as $8 before sliding to $3.60;

Copper climbed from 80 cents to $4.30 before sliding to $3

Gold shot up from $350 to $1900 before pulling back toward $1200.

So what’s happening with commodity prices now? Is this just another correction, or has the game really changed?

Commodity prices have risen against a backdrop of falling interest rates:

The US 10-year Treasury yielded 8% as recently as 1994, and as low as 2.1% during the crash. Recently the consensus target was 4% – before fears of outright deflation drove it to 2.4%. Bond yields have fallen below 1%. Even the bonds of the southern members of the Eurozone yield Treasury-esque returns.

Remarkably, those low yields persist even as major geopolitical outbursts have ended the mostly benign post-Cold War era. The foundations of global economic progress are being shaken by geopolitical earthquakes from Russia and Ukraine to Syria and Iraq, where a new caliphate has been proclaimed.

It seems bizarre, but the world is heading toward a revival of both the Cold War and the Ottoman Empire.

Unfortunately, these concurrent crises are occurring at a time when the great democracies’ leaders bear scant resemblance to those leaders responsible for the end of the Cold War and the launch of global cooperation and free trade: Reagan, Thatcher, and George H.W.Bush.

Mr.Obama won his nomination by voting against the invasion of Iraq. He ran on the promise of ending wars, not starting them. Now, faced with sinking popularity in an election year that could give Republicans complete control of Congress, he naturally fears dragging America into the ISIS chaos – or Ukraine.

Obama is also haunted by the collapse of his most daring and creative foreign policy achievement – the reset with Russia. Mr.Putin has doubled down on his Ukrainian attacks by warning that Russia should be taken seriously, because it is a major nuclear power and is strengthening its nuclear arsenal. Those with long memories recall Khrushchev banging his shoe at the United Nations and shouting, “We will bury you!”

Meanwhile, Western Europe’s leaders show few signs of being prepared for either crisis. Angela Merkel, raised in East Germany, is cautious to a fault. British Premier David Cameron is struggling to prevent Scottish secession and to deal with the likely return of hundreds of ISIS-trained British citizens. (Military analysts generally agree that well-funded returnees with ISIS training are much greater threats than Al Qaeda ever was…yet Cameron has failed to convince his coalition partner to support restraining their re-entry into British Muslim communities.)

The backdrop for long-term investing has, in less than a year, swung from promising to promises broken by wars and threats of more-terrifying wars.

Another unlikely threat is deflation. When central bankers have been running the printing presses 24/7…?

Most economists, strategists, and investors would have deemed deflation a near-impossibility with government debts at all-time highs, funded by money printed at banana-republic rates. Who thought that the Fed would quadruple its balance sheet? And who dreamt that such drastic policies would be sustained for six years and would be accompanied by outright deflation in much of Europe and minimal inflation in the USA?

So why have Brent oil prices fallen from $125 in two years despite production outages in Syria and Libya and repeated cutbacks in Nigeria? Are Teslas taking over the world?

The answer is that the US is once again #1 in oil production, thanks to fracking (in states that allow it). Mr.Obama likes to boast about the new US oil boom, but he has been a bystander to this petro-revolution. According to an oil company executive interviewed in theNew York Times last week, without fracking, global oil prices might be at $200 a barrel, and the world would be in a deep recession. He’s a Texan and thus inclined toward hyperbole, but his point is directionally valid.

US frackers – deploying advances in science and technology with guts and skill – have averted fuel inflation. And farmers, using the tools of modern agriculture – GMO and hybridized seed, farm machinery equipped with GPS and logistics, and carefully monitored fertilizers – have combined with Mother Nature to unleash record crops of corn and soybeans. So much for food inflation.

Capitalism is doing its job: to expand output of goods and services, thereby preventing shortages from derailing recoveries through inflation. That success story means central bankers can keep printing away.

So what should investors do? The S&P’s rally has been sustained through near-zero-cost money used to:

buy back stock to enrich insiders and please activist hedge funds which have borrowed big to buy big; and

prop up the overall market because investors have learned that buying on margin when the costs are minimal – and below dividend yields – just keeps paying off.

Gold loses its luster when inflation seems to be as remote as a pot of gold at the end of the rainbow. It also loses appeal if even a concatenation of crises fails to send investors rushing into the time-tested crisis consoler.

We had predicted in February that 2014 would be the year of increasing geopolitical risks that would challenge conventional asset allocations. We see geopolitical risks expanding from here – not contracting – and stick to our investment advice that the broad stock market is precariously valued. A range of options is available for those who wish to hedge themselves against even worse news.

Gold is part of any such risk mitigation. So are long government bonds.

Most importantly, we have entered an era when wise investors will devote as much time to reading the foreign news as they allocate to reading the investment section.

DOUG CASEY, chairman of Casey Research, LLC, has written several books on crisis investing, including the groundbreaking Crisis Investing: Opportunities and Profits in the Coming Great Depression of 1979.

A renowned mining-stock and international investor, he has appeared on NBC News, CNN and National Public Radio, and also been featured in periodicals such as Time, Forbes, People, Barron’s and The Washington Post.

Now he sees what he calls a “crisis economy” created by trillions of Dollars of debt, a bond bubble on the verge of bursting, and economic distortions that make it difficult for investors to know what is going on behind the curtain. Casey is planning to make the most of this coming financial disaster by buying equities with real value – silver, gold, uranium, even coal.

Here, speaking to The Gold Report‘s sister title The Mining Report, Casey shares his formula for determining which of the 1,500 “so-called mining stocks” on the TSX actually have value.

The Mining Report: This year’s Casey Research Summit is titled “Thriving in a Crisis Economy“. What is the most pressing crisis for investors today?

Doug Casey: We are exiting the eye of the giant financial hurricane that we entered in 2007, and we’re going into its trailing edge. It’s going to be much more severe, different and longer lasting than what we saw in 2008 and 2009. Investors should be preparing for some really stormy weather by the end of this year, certainly in 2015.

TMR: The 2008 stock market embodied a great deal of volatility. Now, the indexes seem to be rising steadily. Why do you think we are headed for something worse again?

Doug Casey: The US created trillions of Dollars to fight the financial crisis of 2008 and 2009. Most of those Dollars are still sitting in the banking system and aren’t in the economy. Some have found their way into the stock markets and the bond markets, creating a stock bubble and a bond superbubble. The higher stocks and bonds go, the harder they’re going to fall.

TMR: When Streetwise president Karen Roche interviewed you last year, you predicted a devastating crash. Are we getting closer to that crash? What are the signs that a bond bubble is about to burst?

Doug Casey: One indicator is that so-called junk bonds are yielding on average less than 5% today. That’s a big difference from the bottom of the bond market in the early 1980s, when even government paper was yielding 15%.

TMR: Isn’t that a function of low interest rates?

Doug Casey: Yes, it is. Central banks all around the world have attempted to revive their economies by lowering interest rates to all-time lows. It’s discouraging people from saving and encouraging people to borrow and consume more. The distortions that is causing in the economy are huge, and they’re all going to have to be liquidated at some point, probably in the next six months to a year.

The timing of these things is really quite impossible to predict. But it feels like 2007 except much worse, and it’s likely to be inflationary in nature this time. The certainty is financial chaos, but the exact character of the chaos is, by its very nature, unpredictable.

TMR: Casey Research precious metals expert Jeff Clark recently wrote in Metals and Mining that he’s investing in silver to protect himself from an advance of what he calls “government financial heroin addicts having to go cold turkey and shifting to precious metals.” Do you agree or are you more of a buy-gold-for-financial-protection kind of guy?

Doug Casey: I certainly agree with him. Gold and silver are two totally different elements. Silver has more industrial uses. It is also quite cheap in real terms; the problem is storing a considerable quantity – the stuff is bulky. It’s a poor man’s gold. We mine about 800 million ounces per year of silver as opposed to about 80 million of gold. Unlike gold, most silver is consumed rather than stored. That is positive.

On the other hand, the fact that silver is mainly an industrial metal, rather than a monetary metal, is a big negative in this environment. Still, as a speculation, silver has more upside just because it’s a much smaller market. If a billion Dollars panics into silver and a billion Dollars panics into gold, silver is going to move much more rapidly and much higher.

TMR: Are you are saying that because silver is more volatile generally, that is good news when the trend is to the upside?

Doug Casey: That’s exactly correct. All the volatility from this point is going to be on the upside. It’s not the giveaway it was back in 2001. In real terms, silver is trading at about the same levels that it was in the mid-1960s. So it’s an excellent value again.

TMR: In another recent interview, you called shorting Japanese bonds a sure thing for speculators and said most of the mining companies on the Toronto Stock Exchange (TSX) weren’t worth the paper their stocks were written on, but that some have been priced so low, they could increase 100 times. What are some examples of some sure things in the mining sector?

Doug Casey: Of the roughly 1,500 so-called mining stocks traded in Vancouver, most of them don’t have any economic mineral deposits. Many that do don’t have any money in the bank with which to extract them. The companies that I think are worth buying now are well-funded, underpriced – some selling for just the cash they have in the bank – and sitting on economic deposits with proven management teams. There aren’t many of them; I would guess perhaps 50 worth buying. In the next year, many of them are likely to move radically.

TMR: Are there some specific geographic areas that you like to focus on?

Doug Casey: The problem is that the whole world has become harder to do business in. Governments around the world are bankrupt so they are looking for a bigger carried interest, bigger royalties and more taxes. At the same time, they have more regulations and more requirements. So the costs of mining have risen hugely. Political risks have risen hugely. There really is no ideal location to mine in the world today. It’s not like 100 years ago when almost every place was quick, easy and profitable. Now, every project is a decade-long maneuver. Mining has never been an easy business, but now it’s a horrible business, worse than it’s ever been. It’s all a question of risk/reward and what you pay for the stocks. That said, right now, they’re very cheap.

TMR: Let’s talk about the US. Are we in better or worse shape as a country politically and economically than we were last year?

Doug Casey: It’s in worse shape now. The direction the country is going in is more decisively negative. Perhaps what’s happening in Ferguson, Missouri, with the militarized police is a shade of things to come. So, no, things are not better. They’ve actually deteriorated. We’re that much closer to a really millennial crisis.

TMR: Your conferences are always thought provoking. I always enjoy meeting the other attendees – it’s always great to talk to people from all over the world who are interested in these topics. But you also bring in interesting speakers. In addition to your Casey Research team, the speakers at the conference this year include radio personality Alex Jones and author and self-described conservative paleo-libertarian Justin Raimondo. What do you hope attendees will take away from the conference?

Doug Casey: This is a chance for me and the attendees to sit down and have a drink with people like Justin Raimondo and author Paul Rosenberg. I’m looking forward to it because it is always an education.

Another highlight is that instead of staging hundreds of booths of desperate companies that ought to be put out of their misery, we limit the presenting mining companies in the map room to the best in the business with the most upside potential. That makes this a rare opportunity to talk to these selected companies about their projects.

TMR: We recently interviewed Marin Katusa, who was also excited about the companies that are going to be at the conference. He was bullish on European oil and gas and US uranium. What’s your favorite way to play energy right now?

Doug Casey: Uranium is about as cheap now in real terms as it was back in 2000, when a huge boom started in uranium and billions of speculative Dollars were made. So, once again, cyclically, the clock on the wall says buy uranium with both hands. I think you can make the same argument for coal at this point.

TMR: You recently released a series of videos called the “Upturn Millionaires”. It featured you, Rick Rule, Frank Giustra and others talking about how you’re playing the turning tides of a precious metals market. What are some common moves you are all making right now?

Doug Casey: All of us are moving into precious metals stocks and precious metals themselves because in the years to come, gold and silver are money in its most basic form and the only financial assets that aren’t simultaneously somebody else’s liability.

“The SITUATION is in place for a dramatic recovery,” Rick Rule told the audience, writes Brett Eversole in Steve Sjuggerud’s Daily Wealth.

I’m here in Vancouver – the heart of the resource-mining industry – attending the Sprott Natural Resource Symposium. It’s a collection of the “best of the best” in the small-cap resource space.

I’m here for a simple reason… while major stock markets around the world have soared over the past few years, small resource companies have absolutely crashed. Falling well more than 50% as a whole.

But today, that means opportunity. Many of the brightest minds here expect the bottom is in, and prices have nowhere to go but higher.

Rick Rule leads a pack of smart industry pros in Vancouver. Rick’s a multi-decade investor in the small-cap mining sector and the Chairman of Sprott US Holdings – an arm of Sprott Inc., which manages $7.6 billion.

During his keynote presentation, he explained why he’s excited about today’s opportunity…

“A market down 75% is precisely 75% more valuable and 75% less risky.”

What surprised me is that Rick wasn’t a cheerleader. He simply explained the rational opportunity in the resource sector today. His big theme was simple…

“A bull market is coming. Don’t waste it.”

Of course, Rick takes a contrarian approach to investing. And right now, things are bad. Folks just aren’t interested in resource investing.

Attendance at this year’s Vancouver conference is at its lowest in years. And it has been in steady decline since the glut began in 2011. But at least they’re still in business…

“The current challenged metals market has led us to make the difficult decision to suspend our events…”

That’s from the Metals and Minerals Investment Conference website. Metals and Minerals is one of the largest resource-based conference groups, with events in New York and San Francisco.

The cause of all of this bad sentiment is simple. Small-cap mining stocks have crashed… If we take a look at the S&P/TSX Venture Index – where most small resource companies reside – the opportunity becomes obvious…

As you can see, this index of small resource companies has crashed over the past three years. It’s now sitting near 2002 and 2008 lows… where the last two great bull markets began.

Importantly, the index has been rising over the last year. The index is up 17% since last June and 9% so far this year.

In short, no one is interested in small-cap resources. Major conference circuits have been canceled and the overall market is down 50%-plus over the last few years. Yet, the market is UP recently.

According to Rick Rule, today’s opportunity is enormous. According to him, “expectations are so low that we can’t help but succeed.”

Yes, it’ll likely be a bumpy ride. But if you have the stomach for it, small-cap resources seem to be poised to move higher.

With US stocks reaching all-time highs, the best opportunities are in beaten and forgotten places. Resources fit that mold perfectly today. Don’t miss the opportunity.

GOLD was a universal “sell” for professional analysts at New Year, writes Adrian Ash at BullionVault.

Losing 30% in 2013, the gold price faced the long-awaited start of US Fed tapering – widely supposed to make fixed-income bonds go down, nudging interest rates higher – plus strong hopes for further gains in world equities. Who needed the barbarous relic?

Half-way through 2014 however, the gold price has since rallied, recovering one-third of 2013’s near-record losses and beating all other major asset classes so far. Why? The market, reckons Nic Brown, head of commodities research at French investment and bullion bank Natixis, “is taking the view that the Fed is behind the curve and may be allowing inflation pressures to creep into the system.” But most other analysts still forecast fresh losses for gold prices in the back-half of 2014, and they still point to US Fed policy and the rising stock market as your No.1 reasons to sell.

ABN Amro’s commodity analysts put it plainly last week. They expect gold’s 11% rise in the first-half of 2014 to be “temporary” because US Fed rates hikes are coming, while the outlook is “positive” for equities. Such thinking makes sense based on 2013’s example. Taper talk pushed bond prices down last year, nudging market interest rates higher. The S&P500 meanwhile returned 32%, a little more than gold prices fell.

Logic might also see a trade-off between gold and rising returns on other assets. Because the metal yields nothing and does nothing. It can’t even rust. Equities and interest-paying investments on the other hand work to increase your money. So gold prices should fall when equities rise, and also when the markets expect higher interest rates. Or so analysts now think.

Consensus and logic are only half-wrong. Almost exactly half wrong in fact. Since 1969 gold prices and US Fed interest rates have moved in opposite directions 47% of the time (rolling 12-month periods). That proportion rises to 54% if you adjust both gold and Fed rates for inflation. But this relationship remains far from strong enough to make certain forecasts. As for equities, gold also moves in the opposite direction to the US stock market just less than half of the time, some 48% of all 12-month periods since 1969.

What’s more, the rolling 12-month correlation of gold prices with the S&P 500 over the last 45 years averages zero. The mean is -0.002, the median 0.02 – as near a perfect non-correlation as equity investors wanting to diversify their holdings could wish for.

To achieve that long-term zero, gold prices in fact swing from a strongly positive to strongly negative correlation with the US stock market, as the chart shows. The 15 months to July 2014 were the longest run of negative correlation in 11 years, suggesting a period of co-movement is now due.

Yet with both gold and equities rising in June, several analysts called it an “unusual combination”, one which “does not normally last long.” During gold’s long bull market starting 2001 however, it rose when stocks fell, and rose again when they gained. So once again, the statistics beg to differ.

So much for the data. Gold bullion is often cast as a “narrative asset” – an investment choice built on stories and sentiment because it lacks a yield on which to base any value analysis. So let’s assume that both equity prices and rate expectations do rise in the second-half of 2014. How might that story run for gold? The most recent period when Fed rates rose with equities should give gold bears pause.

From spring 2004 to summer 2006, and starting from what were then all-time low “emergency rates” of 1.0%, the Fed raised its key interest rate 17 times in “baby step” increments of 25 basis points. The S&P 500 gained 13%, but gold priced in Dollars rose nearly 60%, gaining 48% when adjusted for the change in US consumer prices. All this while the real Fed Funds rate, also accounting for inflation, rose three percentage points to turn positive for the first time since mid-2002.

One explanation is that the big money which drives gold higher or lower doesn’t tend to make decisions based on overnight rates. Instead, it looks at longer-term yields, most notably 10-year US Treasuries. Fed chairman a decade ago, Alan Greenspan noted how his central bank’s tightening cycle hit a “conundrum” in the bond market, because longer-term yields failed to rise in tandem. Indeed, real 10-year yields actually fell between mid-2004 and mid-2006, briefly turning negative for the first time since 1980.

Here in 2014, bond yields have again ticked lower so far, despite the Fed’s quasi-tightening of tapering its quantitative easing asset purchases. Both gold and equities have risen with bond prices. Short-term rates will meantime start the next hiking cycle from new record lows, and the current “emergency rate” has also been applied far longer than Greenspan’s 1.0% low – a full six years by end-2014, against just 12 months for the Maestro’s tech-crash reflation.

You won’t need reminding how the US economy reacted to “normalization” a decade ago. Given 0% money and QE since 2009, can it really bear a return to positive real rates next year? The gold market says not.

“Without a significant ‘bid’ from institutional players, any upside for prices will be limited.”

Tuesday saw another jump in the number of Put options on August and Sept. gold futures, according to Thomson Reuters data, which offer the holder a profit if prices fall.

“For the time being,” say analysts at market-maker Barclays, “we are allowing for further range trading over the coming 3-6 months as gold is caught between the prospect of higher US yields, inflationary expectations, and geopolitical rumbles.”

Over on the currency markets, the Euro touched a 1-month low near its lowest since February after new data showed US factory-gate inflation beating analyst forecasts in June, with prices up 0.4% from May.

The British Pound briefly spiked to new 6-year highs after UK unemployment showed a drop to 6.5% in June.

UK wage growth badly lagged consumer-price inflation, however.

Spot gold priced in British Pounds recovered to £760 per ounce, some 2.8% below last Friday’s 15-week closing high.

Barrick Gold – the world’s largest single gold miner – meantime said its CEO Jamie Sokalsky will step down in September.

Building a gold price “hedge book” equaling well over 600 tonnes of future production by the time spot gold bottomed in 2001, Barrick (NYSE:ABX) then quit those hedges early as prices rose, buying back the last 90 tonnes at what were then record-high prices in 2009.

Barrick chairman John Thornton – who does not plan to replace Sokalsky near-term – said on taking the role last year that he “always thought it made great sense to hedge.”

“The pendulum has swung and the view is evenly split,” says a survey of investor attitudes to gold miner hedging released today by US bank and London bullion market-maker J.P.Morgan.

Having found 70% of clients against gold miner hedging in 2011, J.P.Morgan says the split is now “50% for and 50% against.”

CHRIS MANCINI is a research analyst for the Gabelli Gold Fund, specializing in precious metals mining companies.

With over 15 years of investment management experience, including research analyst positions at Satellite Asset Management and R6 Capital Management, Chris Mancini spends his days seeking value in gold equities – and he thinks he’s found a recipe for success, as he explains here to The Gold Report…

The Gold Report: Cash has flown out of gold funds and into non-gold equities during this bear run in gold. What’s the current Gabelli Gold Fund pitch to investors?

Chris Mancini: Gold should be a long-term allocation to everyone’s portfolio. Owning gold is an insurance policy against the malfunctioning of the world’s monetary system. The current actions of the world’s central banks are unprecedented. Any investor who is unsure of the ultimate outcome of these actions should have a larger percentage of his or her portfolio in gold.

We recommend that investors have a certain portion of that gold allocation in gold stocks. Gold stocks provide income, accretive growth and “optionality.” That optionality is gold in the ground at a discount. Right now investors can buy gold in the ground, in some cases, at less than $100 per ounce and if gold goes to $2000 per ounce then they could see that optionality manifest itself in a big increase in the price of the stock.

TGR: So it’s possible to have security and performance in the same fund?

Chris Mancini: If you pick the right stocks and have that optionality and gold goes up, the performance of the fund will be really good. By the same token, if gold goes down and you own some of these stocks, the price of the fund will most likely go down. In owning a gold fund like ours investors are getting exposure to gold and leverage to a move in the gold price.

TGR: Gold witnessed modest safe-haven and inflation-hedge demand in June after US Federal Reserve Chairman Janet Yellen said that low interest rates are here to stay. Should gold investors expect anything more than a temporary upward trend in gold prices?

Chris Mancini: That depends on the expectation in the markets of where real interest rates are going. Yellen stated that interest rates would be lower for longer but that was coupled with data that showed that inflation in the United States could be accelerating. That shows that real interest rates might become more negative than they are now. And that means that holding cash is a money-losing proposition because cash is losing purchasing power. If interest rates become more negative, that will be positive for gold and it won’t be a temporary phenomenon.

TGR: What’s your price target for gold through the end of 2014?

Chris Mancini: We don’t have one. Our view is that the price of gold is going to be higher at the end of 2014 than it is now. And it’s going to be higher in 2015 than it will be in 2014 and we’re positioning the portfolio to take advantage of that.

TGR: What impact have redemptions from gold exchange-traded funds (ETFs) had on the gold price?

Chris Mancini: Last year 900 tonnes came out of gold ETFs and it was a huge contributing factor to the price of gold declining by 27%. Total annual gold demand is roughly 4,200 tons so if the supply from ETFs goes to neutral then the supply/demand balance this year should shift in the other direction. This year we’ve seen a tiny negative outflow from ETFs, but they’ve been pretty flat. Inflows into ETFs would be a big positive for the price of gold.

TGR: How do the inflows and outflows in your fund compare with 2013?

Chris Mancini: At the beginning of 2014 we had inflows into the fund, and then they flattened out. When we had the big one-day pop in the gold price in June when gold went up $44 per ounce, we actually had outflows from the fund. That might be telling us that we have some people who are playing gold for a quick bounce and aren’t looking at gold from a long-term perspective.

TGR: A recent Gabelli Gold Fund report suggests that Russia may want to diversify its foreign exchange holdings and could look to gold.

Chris Mancini: Russia has around $500 billion of foreign exchange reserves in the form of US Dollar Treasuries and Euro-denominated bonds, largely German, French and some other smaller European country bonds. If there is further geopolitical unrest in or around Russia and increased rhetoric from countries like the United States, Germany, and France meant to impede Russia from taking action in places like Ukraine, Russia might get the sense that the United States and other countries in Nato might impose financial sanctions on Russia.

If broad financial sanctions are placed on Russia, then there could be a question as to whether Russia would be repaid by the countries that they’ve lent money to. In a new Cold War scenario, you would think that Russia would want to diversify out of the bonds of those countries and into something else. What else is there? Gold is an answer. Gold is no one’s liability.

TGR: Where is China in the gold demand picture?

Chris Mancini: Chinese consumers are the largest buyers of gold in the world. That’s related to their fear of holding their currency in the bank or holding it in their mattress. There’s a significant amount of inflation in China, so real interest rates are negative. It behooves the Chinese to diversify out of cash, which is losing its purchasing power. Holding gold is a way to insure against inflation or some kind of issue with the Chinese banking system.

China has around $3.7 trillion of foreign currency reserves. The People’s Bank of China also might want to diversify. If China were to diversify 10% of its foreign currency reserves, $370B, that would be a huge amount of gold to buy, or roughly 3.5 years of the world’s total mined supply of gold.

TGR: A significantly higher gold price would float all boats. But until that happens, what’s your method for picking gold stocks?

Chris Mancini: We try to own the companies that can survive and even benefit from this downturn and then prosper in the upturn. We look for companies that have good assets, good management and a good valuation. Good assets alone should allow the companies to survive; their management teams should help them prosper. We’re looking to buy these companies at reasonable prices.

TGR: What’s one thing a gold investor should know about the current market?

Chris Mancini: The best thing to keep in mind is that even though this market is extremely volatile, you’re in it for the long term. It was very volatile to the downside last year; so far this year it’s been volatile to the upside. Don’t lose hope or exit on a quick run up. You’re getting insurance at a relatively cheap price by owning gold and gold mining companies.

GOLD SMUGGLING into India has risen so sharply over the past year that the new BJP government’s budget this week must ease restrictions on legal imports, says a leading industry figure, to reduce the size of the black market.

Haresh Soni, Chairman of the All India Gems & Jewellery Trade Federation (GJF), calls for the budget to cut gold import duty – now at 10% for more than a year – to just 2%, because the tariff has created a “big parallel economy” of smuggled gold.

BJP leader Narendra Modi, elected as prime minister in May, campaigned on a platform of ending corruption. In January he specifically blamed the previous Congress administration’s anti-gold import rules – imposed last summer to reduce the country’s huge trade deficit – for “smuggling reappearing.

“In the 1960s and 70s, when gold smuggling was big,” Modi said, “it created the underworld, which troubles us even now.”

Looking ahead to Thursday’s first budget from new finance minister Arun Jaitley, “There are many ways in which the rules could be altered,” says Swiss bank and bullion dealer UBS.

“One possibility is a tweak in the import tax which currently sits at 10%; another is a tweak on the 80/20 rule”.

The 80/20 rule means importers must re-export one-fifth of a gold bullion shipment before taking delivery of their next. Confusion over the rule led to a collapse in Indian gold imports last summer. The GJF’s Soni last week urged the government to “abolish the 80:20 rule for gold imports,” as it is the “biggest impediment” to the country’s jewellery industry – an industry Modi was seen backing against the Congress government in late 2013.

However, “there is also the possibility of the government doing/announcing nothing,” say UBS’s analysts, highlighting the government’s preoccupation with India’s current account balance.

For the year 2013, gold smuggling into India probably totaled “in excess of 150 tonnes,” according to consultancy Thomson Reuters GFMS, attributing that growth to the higher premiums paid by Indian buyers over and above world gold prices. In turn, that domestic premium has been led by India’s 10% import duty.

Will Rhind of market-development organization the World Gold Council puts the likely total higher, estimating that “something in the realm of 200 to 250 tonnes” was smuggled into India last year.

World Gold Council research at end-2013 suggested that 75% of Indian households would either continue or increase their current gold buying in 2014. But with legal gold imports dropping by nearly two-thirds since the introduction of the curbs according to official data from the Indian Ministry of Commerce, that only means “unofficial gold will undoubtedly continue to supplement official inflows,” says the Council